Author Topic: Payoff mortgage or invest?  (Read 1394 times)

jtoomey

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Payoff mortgage or invest?
« on: April 10, 2018, 11:14:38 AM »
Hey mustachians! I am working my way toward FI and have a question. I am 32 years old, work full time as a teacher and have part time jobs as well, am married with a 1 year old, and own a home that is about 25% paid off (3.75% on the mortgage). I am currently putting about 35-40% of my take home pay into my IRA and Vanguard funds. I also am putting close to $500/month additional principal toward my mortgage to pay it off early (on track to pay it off before my wife and I are 40!). Should I continue to put this $500 toward the mortgage principal or use that money to bump my savings rate up even further but delay paying off the house?

nereo

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boarder42

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Re: Payoff mortgage or invest?
« Reply #2 on: April 11, 2018, 08:28:29 AM »
Yeah no reason to pay that off. Keep it to term. Retire earlier and have more safety in fire

frugaliknowit

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Re: Payoff mortgage or invest?
« Reply #3 on: April 11, 2018, 09:48:44 AM »
The answer to your question depends on your risk tolerance.  Only you (and spouse/partner) can determine that.  Paying off or prepaying the mortgage is zero risk with a guaranteed rate of return of Mortgage rate * (1-Marginal tax rate), assuming you exceed the standard deduction; otherwise it's the mortgage rate.

Do you hold bonds or bond funds in any of your accounts?  If so, you can substitute bond holdings with prepaying mortgage (3.75% is way better than what decent grade bonds are paying...).

Prepaying mortgage IS savings.

Dicey

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Re: Payoff mortgage or invest?
« Reply #4 on: April 11, 2018, 10:25:34 AM »
The answer to your question depends on your risk tolerance.  Only you (and spouse/partner) can determine that.  Paying off or prepaying the mortgage is zero risk with a guaranteed rate of return of Mortgage rate * (1-Marginal tax rate), assuming you exceed the standard deduction; otherwise it's the mortgage rate.

Do you hold bonds or bond funds in any of your accounts?  If so, you can substitute bond holdings with prepaying mortgage (3.75% is way better than what decent grade bonds are paying...).

Prepaying mortgage IS savings.
Re: the statement in bold above - not necessarily. In fact, prepaying can actually cost you money in the long run.

Assessing risk tolerance should be done after studying the topic thoroughly, not just relying on "feelings."

The links helpfully provided by nereo are an excellent place to start.

csprof

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Re: Payoff mortgage or invest?
« Reply #5 on: April 11, 2018, 10:40:37 AM »
The answer to your question depends on your risk tolerance.  Only you (and spouse/partner) can determine that.  Paying off or prepaying the mortgage is zero risk with a guaranteed rate of return of Mortgage rate * (1-Marginal tax rate), assuming you exceed the standard deduction; otherwise it's the mortgage rate.

Do you hold bonds or bond funds in any of your accounts?  If so, you can substitute bond holdings with prepaying mortgage (3.75% is way better than what decent grade bonds are paying...).

Prepaying mortgage IS savings.
Re: the statement in bold above - not necessarily. In fact, prepaying can actually cost you money in the long run.

Assessing risk tolerance should be done after studying the topic thoroughly, not just relying on "feelings."

The links helpfully provided by nereo are an excellent place to start.

But the statement is right.

Keeping 80% of your net worth in a savings account is "savings" - it's just savings that's going to lose its value over time due to inflation, and give you a very poor return compared to alternatives, but it's approximately guaranteed not to vary in value.

I don't disagree with your bigger point, of course:  Excessive amounts of your portfolio in too-conservative savings has substantial inflation risk, and (counterintuitively) actually increases the risk of your portfolio not making it through your target. 

Basenji

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Dicey

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Re: Payoff mortgage or invest?
« Reply #7 on: April 11, 2018, 11:19:52 AM »
The answer to your question depends on your risk tolerance.  Only you (and spouse/partner) can determine that.  Paying off or prepaying the mortgage is zero risk with a guaranteed rate of return of Mortgage rate * (1-Marginal tax rate), assuming you exceed the standard deduction; otherwise it's the mortgage rate.

Do you hold bonds or bond funds in any of your accounts?  If so, you can substitute bond holdings with prepaying mortgage (3.75% is way better than what decent grade bonds are paying...).

Prepaying mortgage IS savings.
Re: the statement in bold above - not necessarily. In fact, prepaying can actually cost you money in the long run.

Assessing risk tolerance should be done after studying the topic thoroughly, not just relying on "feelings."

The links helpfully provided by nereo are an excellent place to start.

But the statement is right.

Keeping 80% of your net worth in a savings account is "savings" - it's just savings that's going to lose its value over time due to inflation, and give you a very poor return compared to alternatives, but it's approximately guaranteed not to vary in value.

I don't disagree with your bigger point, of course:  Excessive amounts of your portfolio in too-conservative savings has substantial inflation risk, and (counterintuitively) actually increases the risk of your portfolio not making it through your target.
I didn't say it was wrong, I said "not necessarily". This site is dedicated to reaching FIRE in the most efficient way possible. Pre-paying cheap, affordable, fixed-rate mortgages just ain't it, for most people. The two significant exceptions, IMO, are folks who live in countries there mortgage interest is not tax deductible (Ouch!), and folks who live in flyover country, where perfectly suitable housing can be procured for well below $100k.

Otherwise, I think we are singing in the same choir, csprof.

neo von retorch

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Re: Payoff mortgage or invest?
« Reply #8 on: April 11, 2018, 11:51:27 AM »
Hey mustachians! I am working my way toward FI and have a question. I am 32 years old, work full time as a teacher and have part time jobs as well, am married with a 1 year old, and own a home that is about 25% paid off (3.75% on the mortgage). I am currently putting about 35-40% of my take home pay into my IRA and Vanguard funds. I also am putting close to $500/month additional principal toward my mortgage to pay it off early (on track to pay it off before my wife and I are 40!). Should I continue to put this $500 toward the mortgage principal or use that money to bump my savings rate up even further but delay paying off the house?

Let's try to stick to the original post, and break it down into inputs, questions and outputs!

Facts
  • Goal "FI" (evidence: "working my way toward FI")
  • Mortgage: 20+ years remaining @3.75% (evidence "25% paid off")
Question
  • Should I continue to put this $500 toward the mortgage principal?
Education
  • Your savings rate will not change because you transfer money from one account to another. Transferring money from your checking account to your mortgage OR your IRA has no material impact on your net worth, or on how much of your income goes towards expenses.
  • Over a 20 year timeline (how long it might take to pay off your mortgage if you do not pre-pay), you have a very high chance of doing (substantially) better than 3.75% from investments. If your timeline was much shorter, or your rate was much higher, it would be much less clear cut.
  • Think of a mortgage not as an expense, but as a negative investment (-3.75%). Yes it's great to pay off that negative investment, but to do so, you have to give up investing in things that tend to pay ~10% annually over 20 year periods (i.e. equities.) When you do finally pay off your mortgage, you knock out principal (which is just an account transfer) and interest (a negative investment.) Of course, you still have to pay insurance and taxes as before.
Options
  • Continue to pay off the mortgage early, but very likely to increase time to FI.
  • Stop paying off the mortgage. Put more money into higher return investments. If so desired, when on a much shorter timeline (i.e. < 7 years left on mortgage, begin to pay it off more quickly -- this is much less likely to harm your FI goals, and on this short timeline, investments are much less reliably profitably)
« Last Edit: April 11, 2018, 11:54:51 AM by neo von retorch »

boarder42

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Re: Payoff mortgage or invest?
« Reply #9 on: April 11, 2018, 11:52:48 AM »
Bonds and pre paying a mortgage are not remotely comprable. Bonds can be rebalanced a mortgage cannot easily be rebalanced. The and return on bonds historically is much higher than 3.75%.

As for risk pre paying a mortgage is riskier than investing it all in stocks. Unless you can pay it all off in a lump sum.

boarder42

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Re: Payoff mortgage or invest?
« Reply #10 on: April 11, 2018, 12:05:23 PM »
Also you should look at the real return on a mortgage. When adjust for normal inflation a 3.75% mortgage pre payment gains you a historical ROI of around .5%.

jtoomey

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Re: Payoff mortgage or invest?
« Reply #11 on: April 12, 2018, 11:09:05 AM »
Hey mustachians! I am working my way toward FI and have a question. I am 32 years old, work full time as a teacher and have part time jobs as well, am married with a 1 year old, and own a home that is about 25% paid off (3.75% on the mortgage). I am currently putting about 35-40% of my take home pay into my IRA and Vanguard funds. I also am putting close to $500/month additional principal toward my mortgage to pay it off early (on track to pay it off before my wife and I are 40!). Should I continue to put this $500 toward the mortgage principal or use that money to bump my savings rate up even further but delay paying off the house?

Let's try to stick to the original post, and break it down into inputs, questions and outputs!

Facts
  • Goal "FI" (evidence: "working my way toward FI")
  • Mortgage: 20+ years remaining @3.75% (evidence "25% paid off")
Question
  • Should I continue to put this $500 toward the mortgage principal?
Education
  • Your savings rate will not change because you transfer money from one account to another. Transferring money from your checking account to your mortgage OR your IRA has no material impact on your net worth, or on how much of your income goes towards expenses.
  • Over a 20 year timeline (how long it might take to pay off your mortgage if you do not pre-pay), you have a very high chance of doing (substantially) better than 3.75% from investments. If your timeline was much shorter, or your rate was much higher, it would be much less clear cut.
  • Think of a mortgage not as an expense, but as a negative investment (-3.75%). Yes it's great to pay off that negative investment, but to do so, you have to give up investing in things that tend to pay ~10% annually over 20 year periods (i.e. equities.) When you do finally pay off your mortgage, you knock out principal (which is just an account transfer) and interest (a negative investment.) Of course, you still have to pay insurance and taxes as before.
Options
  • Continue to pay off the mortgage early, but very likely to increase time to FI.
  • Stop paying off the mortgage. Put more money into higher return investments. If so desired, when on a much shorter timeline (i.e. < 7 years left on mortgage, begin to pay it off more quickly -- this is much less likely to harm your FI goals, and on this short timeline, investments are much less reliably profitably)


Good advice! I think I'll put the money towards retirement and index funds and keep the mortgage payments standard. There certainly is an appeal of living in a totally paid off house, but there is a greater appeal to reaching FI earlier!

Dicey

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Re: Payoff mortgage or invest?
« Reply #12 on: April 13, 2018, 10:57:24 AM »
Good advice! I think I'll put the money towards retirement and index funds and keep the mortgage payments standard. There certainly is an appeal of living in a totally paid off house, but there is a greater appeal to reaching FI earlier!
Abso-fucking-lutely! As one who is fortunate enough to have both, FIRE is way better!